All you need to know about promoter funding by debt mutual funds?
The Zee episode has brought mutual funds’ exposure to loans against shares under the spotlight.
What is promoter funding?
Many a time promoters need funds for working capital, business growth, or even acquisitions. With many PSU banks going slow on lending, debt mutual fund schemes have come as an alternative for promoters to borrow money. Some categories of mutual fund schemes such as credit risk, medium term plan and dynamic bond funds often finance these promoters against collateral. Fund houses provide finance to promoters of well-managed corporates against their stake in that operating company. This is generally done against the promoter shareholding in prime group companies, which are given as collateral to the fund house.
Why do debt mutual fund schemes put in money in such structures?
Many investors put in money in certain categories of debt funds to earn higher returns than traditional fixed income instruments. Such debt schemes look for a number of investment options that can earn higher returns for their unit holders. One such opportunity, is promoter funding secured by a pledge of listed shares of the promoter.
How secured are these structures?
Typically the structures are backed by promoter shares which enjoy good liquidity on the stock exchanges. Typically the fund house has a cover of 1.5-2.5x on the money it lends. The shares can be sold in case the borrower delays payment. In case the price of the security falls in the stock market, the fund house asks the promoter to top up the collateral or give some other liquid security like a fixed deposit.
What is the investment risk and return in such structures?
There is a trade off between risk and returns. Generally the rating of the structure is lower, which gives the potential to a scheme to earn higher returns. Many such companies which opt for this method of funding may not have strong financials or margins and rely on the strength of the flagship group company. Such structures could give returns which are 200-400 basis points higher than traditional debt instruments like government bonds, AAA or AA rated corporate paper, commercial paper and T bills. Such securities suffer from default risk and liquidity risk. The promoter may not have additional shares for top up in case the share price moves down sharply, which could cause a loss to the unitholders. Incase a fund needs to sell the security before maturity, due to redemption pressures there would be a lack of buyers in the market or buyers at a very low price.